17/10/2017 - 14:32

No way to rebottle the retail genie

17/10/2017 - 14:32

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ANALYSIS: New retail arrivals continue to pile pressure on established operators, with Wesfarmers feeling the pain on several fronts.

No way to rebottle the retail genie
The presence of international players such as Aldi and Costco are squeezing Coles and rival Woolworths. Photo: Attila Csaszar

Sky-high household debt, combined with rising power costs, a fear of higher interest rates, and increasing competition from international invaders, has turned an unwelcome spotlight onto the Australian retail industry.

If that isn’t enough to worry shopkeepers, landlords and investors, there are fresh questions being asked of the British expansion by the Bunnings division of Australia’s biggest retailer and one of Western Australia’s most widely held stocks – Wesfarmers.

Domestically, the challenge facing all aspects of retail could be clearly seen in the latest survey of the industry by the Australian Bureau of Statistics, which revealed the biggest two-month sales fall in seven years.

A retail sales decline of 0.2 per cent in July accelerated in August to a decline of 0.6 per cent compared with the same months in 2016. The falls are in contrast to forecasts from economists of a rise in sales for August of 0.3 per cent.

A breakdown of the latest retail sales data reveals weakness in all sectors, including supermarkets, department stores and even hardware.

Investment bank Credit Suisse noted that supermarket sales declined by 0.5 per cent in a month-on-month (August versus July) basis.

“Our weekly pricing survey shows particularly aggressive price declines across our fruit and vegetable basket, a trend that continued in September,” Credit Suisse said.

“On average in September our fruit and vegetable basket was priced 25 per cent lower year on year at Coles, 21 per cent lower at Woolworths, and 15 per cent lower at Aldi.”

Sales at department stores, which have been hit hardest by internet retailing, were down 1.4 per cent in August compared with the same month last year.

“Department stores continue to face headwinds that we think are primarily due to increased competition,” Credit Suisse said.

Another investment bank, Morgan Stanley, said housing-linked retail items such as furniture slowed to an annual growth rate of 2.5 per cent in August compared with 3.3 per cent in July and 6.9 per cent in June.

“Interestingly, online sales growth has accelerated as store growth has decelerated.” Morgan Stanley said.

“Much is made of Amazon’s entry into Australia, which we believe will be in November, but even ahead of this potential game changer, online sales growth is accelerating, up 10.3 per cent in August.”

It is into a falling market, and one increasingly influenced by the internet, that an arm of the giant German retail business Schwarz Groupe has unveiled plans to enter Australia.

Schwarz, the world’s fourth biggest retailer, already operates its Lidl brand of cut-price food stores, and now plans to open its Kaufland brand of oversized supermarkets.

The planned entry of Kaufland, starting in Adelaide, adds pressure onto the food-retailing sector of retailing, in which American group Costco is already building a solid following among shoppers prepared to buy big and stockpile at home.

The appeal of Costco, which is yet to enter the WA market, is its warehouse-style layout and discounted prices for bulk buying, along with surprising savings for shoppers who want to buy a lot in one visit, something an analyst at Morgan Stanley does regularly.

Thomas Keirath, in the Sydney office of the bank, monitors Costco closely, writing a series of reports titled ‘The Kieraths go to Costco’ as part of a process designed to monitor retail prices.

In his latest report published two weeks ago, Mr Keirath compared a basket of groceries bought at a new Costco store in the north-west Sydney suburb of Marsden Park with a similar basket of groceries from Woolworths and Wesfarmers subsidiary Coles.

What cost $497 for 27 separate products at Costco cost 20 per cent more at Coles and Woolworths, with a surprising feature of the price comparison being an infinitesimal price difference (46 cents, or 0.1 per cent) between Coles and Woolworths – $622.50 versus $622.04, respectively.

In a separate research note on the entry of Kaufland, Morgan Stanley said the new competitor would pile pressure onto all retailers.

“The entry of a well-capitalised discount format with a strong track record and long-term investment horizon has clear negative implications for all retailers under our coverage,” Morgan Stanley said.

In detail, Morgan Stanley said the major implication of Kaufland’s entry would be a further squeeze on profit margins across food and non-food products.

However, the bank added an ominous note for local retailers that the two big German retailers – Kaufland and Aldi – could launch a private retail war, with the major supermarkets caught in the crossfire.

Before those comments were published, Morgan Stanley had downgraded its investment recommendations on both Wesfarmers and Woolworths to ‘sell’, a view held by most other investment banks as profits in the retail sector are squeezed by the combination of falling sales and rising competition.

Macquarie is a lone voice among the major investment banks recommending Wesfarmers as a ‘buy’; but that’s largely because of stronger profits expected from its coal mining business.

Retail operations, which dominate the current structure of Wesfarmers, are forecast to post a marginal increase in sales in the current financial year, with the Bunnings home improvement business the one bright spot in Australia (but not Britain).

Concern about Bunnings’ British adventure has been expressed in this column on several occasions in the past, a view based on personal observation and the problems facing the British economy.

The latest Macquarie analysis of Wesfarmers will cause some Wesfarmers shareholders to question the cost of the British expansion and the time it might take to turn losses into profits.

While just the view of one investment bank, the forecast of Bunnings UK will keep the debate going because Macquarie reckons it will continue losing money for several years, with annual earnings before interest and tax (EBIT) declining slightly before rising.

Macquarie is tipping an EBIT loss in the current financial year of $78 million, declining over the next two years to $66 million and $51 million respectively, before rising to $90 million in the 2020 financial year.

For incoming Wesfarmers chief executive Rob Scott, the retail challenges are piling up. If it’s not international rivals such as Kaufland, Costco and Aldi nipping at the heels of Coles, it’s the need to continue shipping capital across to Britain to lift Bunnings UK to a point where it can trade profitably.

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